The theory goes a bit like this: United Parcel Service (NYSE:UPS) and FedEx (NYSE:FDX) are both stocks whose revenue growth correlates with economic growth, the stock market, and, ultimately, each other. Unfortunately, the theory is wrong -- at least it has been in 2014. UPS has managed to decline 4.4% in 2014, while the S&P 500 is up 7.4% and FedEx has risen more than 16% in the same period. Why is this so, and what do investors need to know about UPS going forward?
4 reasons UPS has underperformed
The first three reasons are matters that also relate to FedEx, while the last reason talks about UPS' position relative to FedEx:
- Severe winter weather, and an unexpected spike in demand (mainly caused by unexpectedly strong e-commerce demand), hurt the performance of delivery companies such as UPS and FedEx.
- The growth in ground-based e-commerce has caused margin pressures as business-to-consumer, or B2C, packages tend to be lighter weight and lower margin.
- Both companies have needed to invest to ensure that peak demand is met this year, as they need to avoid a repeat of last year's disappointments.
- In a sense, UPS has underperformed FedEx because the investment case for the latter is partly based on the execution of its productivity improvement plan -- something FedEx is delivering on.
Weather, e-commerce, and FedEx
Last winter's severe cold weather across much of the U.S. created a number of issues for UPS. Its own operations were hit by the cold snap, and e-commerce demand surged partly because shoppers couldn't reach the malls. In addition, a combination of fewer Christmas shopping days than usual and intensive promotional activity created an unprecedented surge in peak demand for e-commerce deliveries. The result is that UPS has had to make extra investments to deal with peak demand -- something that Fools can read about in more detail here.
While dealing with peak demand created by e-commerce has created its own issues, UPS has also had to invest more than its management originally expected in order to deal with stronger-than-expected growth in B2C packages. In fact, Fools already know that the company recently reduced its full-year EPS guidance, partly because of increasing its planned investments by $75 million.
Moreover, the relative growth in e-commerce B2C packages has created a shift in the revenue mix, which is pressuring margin growth. These types of packages tend to be lighter weight and therefore generate less revenue per package. Readers can look here for more detail on the margin pressures.
Finally, the underperformance relative to FedEx is possibly because the investment cases for the two stocks have been different this year. In previous years, both companies' growth prospects depended on growth in global trade, and the market has treated them this way. However, this year FedEx is in the process of a productivity improvement plan that's intended to increase profitability by some $1.6 billion by 2016. FedEx's productivity improvements are discussed here in more detail. The fact that FedEx has executed well on these plans has led the stock to outperform UPS this year.
Where next for UPS?
Investors will be looking forward to the company's investor conference on Nov. 13, when management is set to discuss where the company's long-term margins and earnings growth could be headed. There is no doubt that investors have had reason to reappraise their view on these metrics, because the trend toward lighter-weight B2C packages appears to be a long-term one. Moreover, the United States Postal Service has been making aggressive moves to capture large e-commerce customers.
However, if any business knows how to utilize scale to its advantage, it's UPS, and Fools should keep a close eye out for what its management says in the future. The company has had some unexpected setbacks in 2014, but its underlying business remains strong, and many of its new investments should generate productivity improvements in the future.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends FedEx and United Parcel Service. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.